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May 5, 2013

'Talk about Softened Austerity at the Eurozone Level is Pure Nonsense'

A self-described "Gloomy European Economist" argues that the key to recovery
in Europe is boosting aggregate demand, but "No expansion of eurozone aggregate
demand can happen without a reversal of policies in Germany." Unfortunately, "there is
no sign that core countries like Germany will finally let their domestic
demand expand":

It Ain’t Over ’til It’s Over: Austerity partisans had a couple of rough
weeks, with highlights such as the Reinhart and Rogoff blunder, and Mr Barroso’s
acknowledgement that the European periphery suffers from austerity fatigue.
In spite of the media trumpeting it all over the place, and proclaiming the
end of the austerity war, it is hard to believe that eurozone austerity will
be softened. Sure, peripheral countries will obtain some (much needed)
breathing space. But this is neither a necessary nor a sufficient condition
for a significant policy reversal in the EMU. The problem is that there is
no sign that core countries like Germany will finally let their domestic
demand expand. And yet, this is what is needed. ...

We are not going to see the pre-crisis level of activity for at least 2 or 3
years... Domestic demand is down almost 6%, mostly because of investment
(-19.1%). It makes no sense claiming otherwise: this is a Keynesian (sorry
for the bad word; should I rate this post R?) aggregate demand deficiency
crisis. ... As a sidenote, the dramatic decrease of investment makes one
wonder what will be left of the EMU capacity to produce, once aggregate
demand resumes. The only two engines of growth, today are public consumption
(!) and exports, both at around +4% with respect to the pre-crisis peak ;
they compensate, unfortunately only partially, for the dramatic drop in
domestic private demand. Further reducing government spending, as will most
probably keep happening, will lay the burden of recovery only on the
external component. It is worth repeating that this small-country-syndrome,
in the second largest economic bloc of the world, can only spell disaster.
It is impossible to conceive a long-term reliance of our prosperity on
demand coming from the rest of the world, as proponents of the “Berlin view”
would like us to believe.

It seems very hard not to read from this figure that the EMU needs to
seriously boost domestic demand, if it wants to break free from the
recessionary spiral that is afflicting it since 2008. And once this is
agreed, then it becomes clear why this talk about softened austerity at the
eurozone level is pure nonsense. The eurozone is compressing public
expenditure, while the private sector, downbeat or financially constrained,
keeps expenditure stagnant. Countries that can afford it (hint: their
longest river is called Rhein…) should increase their domestic demand. Not
because they need to save those sinners in the periphery, but because of
their size. No expansion of eurozone aggregate demand can happen without a
reversal of policies in Germany.

Whether rebalancing will happen through higher wages (much needed), or
increased public spending, is not for me to say. But unless Germany accepts
to act as the locomotive of European growth and increases its domestic
demand, giving one extra year for budget consolidation to Greece, Spain or
Italy, will not end austerity. It ain’t over…